The ECB missed an opportunity to jump start growth in Europe

In our view, the European Central Bank’s (ECB’s) recent
policy-setting meeting continued to suggest that we are in the
midst of a regime change for policy, markets and economies.
Indeed, in much of the developed world central banks have begun
the process of stepping back from the extraordinary monetary
accommodation of recent years, with the prospect of greater
fiscal policy stimulus on the horizon.

In the eurozone, this means that after March 2017 the ECB will
step down its quantitative easing (QE) purchases from €80
billion/month to €60 billion/month through the end of the year.
And while President Draghi vehemently denied that this move
amounted to a “tapering” of the program, and has emphasized
policy flexibility should conditions deteriorate, we find it a
bit difficult to interpret it otherwise. Thus, while we applaud
the Governing Council for being deliberative with policy
adjustments that indicate a workable compromise, as we recently argued to the Financial
Times, we think an opportunity for bolder policy
re-imagination was missed.

What is needed in Europe instead of merely more conventional QE
is a bold policy that can circumvent disruptive debt market
conditions, like the U.S. “taper tantrum,” still maintain
heightened accommodation to promote higher inflation
expectations, and simultaneously hold real interest rates below
nominal gross domestic product (GDP) growth in order to promote
system-wide deleveraging. Further, engineering a gentle form of
nominal rate increase alongside steeper curves would also help
alleviate financial sector pressures, and we may in fact see
modestly steeper curves in Europe due to the modality changes
just made.

The ECB should have increased and revamped already existing asset
purchases in order to promote regional infrastructure spending,
trade development, and balance-sheet intensive corporate
activities (such as vendor finance), in a manner that more
effectively marries the fiscal impulse to monetary conditions and
has the potential to help re-rate growth and inflation.

More specifically, the ECB asset purchase program can more
effectively harness the purchasing of the debt of
supranational and sovereign agencies that already are
mandated to work on infrastructure and trade development,
smoothing the path for more national-level fiscal spending to
follow. The European Investment Bank (EIB), the European Fund
for Strategic Investment and various national
trade/infrastructure agencies are the institutions that
together could catalyze that change.

Importantly, these entities are not subject to the
restrictions associated with the national capital key for QE
purchases, so there would be virtually unlimited amounts of
debt that could be purchased by the central bank, eliminating
debt availability as a rationale for QE tapering. Vitally,
sovereign-drawn capital for these entities should be treated
as exactly that—capital—and not as an expense that would
exacerbate fiscal surpluses or deficits.

The ECB has already made use of supranational bonds in its
asset purchase schemes—just not enough, in our estimation.
The EIB alone could expand its balance sheet by roughly €140
billion without one more euro of capital. Thanks to an
attractive structure of callable capital and favorable
gearing, a modest €5 billion additional contribution of
paid-in capital can increase EIB’s balance sheet by more than
€281 billion from today. The ECB could have theoretically
substituted the €20 billion/month reduction of its purchases
of extremely low yielding bonds for 14 months of incremental
EIB purchases.

Additionally, governments have seemingly not understood the
tremendous potential they have in public/private
partnerships, whereby official institutions could tranche and
term-out financing, potentially drawing in tens of billions
of euros of private capital and providing for exponentially
more powerful economic impact. Indeed, the massive demand for
decent and stable income from insurance companies, pension
funds, and asset managers could make a program of this kind
transformational for Europe. Failure to act, or to act too
conventionally, on the other hand, risks both economic
stagnation and the potential for unforeseen political
disruptions forcing European policy makers into worse
decisions later on.

The ECB had the chance to innovate on December 8, moving from
an initial emergency phase of QE to a more durable,
multilateral framework of monetary accommodation that could
promote sustainable growth in Europe, but it unfortunately
missed the opportunity. More than anything, what is required
now is bold vision and political courage. The Governing
Council should have viewed this meeting not in the
conventional frameworks that have thus far failed to re-rate
European growth, but as an opportunity for dynamic and
productive monetary policy change.